Hewlett-Packard has stepped in as a surprise buyer for Palm. HP will buy Palm and its webOS operating system for $1.2 billion, or $5.70 a share. The deal saves Palm, which said its business was unraveling quickly.

Updated: Hewlett-Packard has stepped in as a surprise buyer for Palm. HP will buy Palm and its webOS operating system for $1.2 billion, or $5.70 a share.

With the deal HP becomes a smartphone player because it will acquire an operating system, intellectual property and handset designs. It's likely that HP CEO Mark Hurd will give Palm some manufacturing discipline and scale.

Palm put itself up for sale after struggled to move inventory at Verizon Wireless. The company had innovative software, but failed to keep up with new smartphone designs. At the $1.2 billion price, Palm's primary investors---Elevation Partners---get out of the company roughly in tact. Meanwhile, Palm's business was just getting worse. The company projected fourth quarter revenue between $90 million and $100 million. Palm said in an SEC filing:

Revenues for the fourth fiscal quarter are being impacted by slow sales of the company’s products, which has resulted in low order volumes from carriers.

Wall Street estimates, which have come down dramatically, were projecting Palm revenue of $164 million for the fourth quarter. Simply put, HP just saved Palm from near certain doom.

You could argue that HP overpaid given the rate Palm's sales were tanking, but the deal revolves around the future of the WebOS and what HP can do with it--think Slate. According to Stifel Nicolaus, the WebOS was worth $800 million to $1 billion for a highly motivated buyer. For HP, the Palm deal means that Hurd has another part of the company's IT stack to fill out. HP has basically been a no-show in the smartphone market---aside from the iPaq (right)---but with Lenovo rumored to be a bidder for Palm and Dell aggressively moving into smartphones, the company had to make a move.

In a conference call to discuss the deal this afternoon, Executive VP Todd Bradley repeatedly referenced "connected" devices and the strengths on both side. HP isn't sharing any product rollout plans until they get closer to the closing of the deal, which is expected in the third quarter, pending regulatory approval.

However, he suggested that one of the first moves would be to use HP's retail and commercial channels to broaden the reach for distribution of Palm's consumer smartphones. As for expansion into tablet or slate products, Bradley said those are new markets that have potential for adoption by both consumers and commercial verticals, such as health care and education.

Asked why HP didn't just jump on to the Android bandwagon, Bradley said that the product lines - whether smartphones, tablets or netbooks - were still in the early stage market and that HP will be able to attract and build a developer market that will make WebOS more compelling and more competitive.

It also came as no surprise that HP - as a Silicon Valley pioneer built on the spirit of innovation - might want to maintain control over the path of a mobile OS for better integration with other products. Bradley mentioned that the both companies are Silicon Valley-based companies with "a passion for innovation."

And while no one asked the question directly, Bradley also noted that Microsoft will remain a strategic partner of HP, and said it is a "huge piece of our business today and will continue to be so."

Leverage HP's channel and enterprise connections to make Palm a player;

And create a mobile ecosystem.

Add it up and the HP purchase of Palm may be enough to keep developers---a primary factor in smartphone success---in the fold.

Palm CEO Jon Rubinstein is expected to remain at the company.

There are multiple threads to ponder in this deal. Among them:

With Palm, HP can become a viable threat to Research in Motion and Apple. On the Apple front, Palm has a nice operating system that was built to compete with the iPhone. However, the ecosystem for Palm just wasn't there. HP could change that equation somewhat, but it's unclear whether it'll pan out from a consumer perspective. More likely, HP will make Palm an enterprise play and look to threaten RIM with mobility. HP can make Palm devices a part of the IT stack Hurd is pushing.

Can HP keep developers in the fold? If you're a developer looking at this deal you can breathe a little easier because Palm won't disappear tomorrow. That fact, however, doesn't change Palm's market share and growth prospects. HP will have to turbo charge growth for developers to remain interested and double down on the WebOS.

The tablet connection. HP has been making a lot of noise about its Slate, an iPad rival. It's unclear whether Windows 7 will be lightweight enough for a smallish netbook replacement. Palm's WebOS could show up on tablets just like Android and the iPhone OS. Andrew Nusca took the liberty of mocking this one up.

HP's smartphone strategy emerges. Will HP be able to keep up with the cool smartphone kids like HTC and Apple on the design front. Palm designs haven't been able to keep up and HP is an unknown entity.

The emergence of PC vendors as smartphone dealers. HP, Lenovo and Dell are all plotting smartphones. The convergence of the PC and smartphone and tablets could accelerate. Do these PC brands translate to smartphones?

Will HP play with Microsoft's Windows Phone 7? HP counts Microsoft as a long-time partner. Now it owns its own operating system the relationship could be strained.

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